Suppose you own a small company that is contemplating construction of a suburban office block. The cost of buying the land and constructing the building is $700,000. Your company has cash in the bank to finance construction. Your real estate adviser suggests that you rent out the building for two years at $30,000 a year and predicts that at the end of that time you will be able to sell the building for $840,000.

Thus there are now two future cash flows--a cash flow of C1 = $30,000 at the end of year 1 and a further cash flow of C2 = ($30,000 + 840,000) = $870,000 at the end of the second year.

Required:
a. Calculate the NPV of the office building venture at interest rates of 5, 10, and 15%.
b. At what discount rate (approximately) would the project have a zero NPV?

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ewomazinoade ewomazinoade · Answer 1 · 2020-10-08T02:49:30+02:00

Answer:

NPV when discount rate is 5% = $117,687.08

NPV when discount rate is 10% = $46,281

NPV when discount rate is 15% = $-16,068.05

B. 13.65%

Explanation:

Net present value is the present value of after-tax cash flows from an investment less the amount invested.

NPV can be calculated with a financial calculator

Cash flow in year 0 = $-700,000.

Cash flow in year 1 = $30,000

Cash flow in year 2 = ($30,000 + 840,000) = $870,000

NPV when discount rate is 5% = $117,687.08

NPV when discount rate is 10% = $46,281

NPV when discount rate is 15% = $-16,068.05

To determine which discount rate that would give the project a zero NPV, we are supposed to calculate the Internal rate of return

Internal rate of return is the discount rate that equates the after-tax cash flows from an investment to the amount invested

IRR can be calculated using a financial calculator

Cash flow in year 0 = $-700,000.

Cash flow in year 1 = $30,000

Cash flow in year 2 = ($30,000 + 840,000) = $870,000

IRR = 13.65%

To find the NPV using a financial calculator:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. after inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.

3. Press compute

To find the IRR using a financial calculator:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. After inputting all the cash flows, press the IRR button and then press the compute button.